Pension spiking is a practice in which city employees convert certain benefits such as unused sick time or saved vacation pay to boost their pension benefits. There are two main factors by which pension payouts are calculated: the salary – usually the highest salary – of the employee and the length of service of the employee. Pension spiking can be done either by converting saved sick and vacation pay to boost the salary on which the pension is calculated or by crediting saved sick and vacation time to artificially extend the length of service on which the pension is based. This practice is not illegal in most cities and states and is allowed or prohibited at the discretion of administrators. In Phoenix, the practice is allowed for many public safety workers and executive level employees but denied to rank-and-file employees.

Actually, that’s not the only way spiking occurs, but it’s one way where the public employees have direct control.

The issue is that most public pension benefit formulas are based on final salary amounts, though sometimes also final income from the job. So in some cases, the employees work boatloads of overtime the last couple years to give their pensions a spike.

Another way involves collusion of one’s superiors: you get a raise just a couple months before you retire, and your benefit is calculated at that new level.

A 2005 pension law was intended to rein in big salary spikes that boost retiree benefits and pension costs statewide, imposing cash penalties on districts that gave raises larger than 6 percent to outgoing educators.

But over the last decade, hundreds of school districts paid the so-called penalties and doled out steeper raises anyway, state data show, pushing some administrator salaries higher than $300,000, and, in one case, $400,000.

In a double whammy, local taxpayers had to foot the bill for those salary spikes, as well as the special penalty payments required to cover higher pensions from the raises.

Yeaaaaah, that’s kind of a problem.

To be sure, the school district that’s paying the penalty has less to play with for other things, but when it’s Other People’s Money, the answer is always to raise taxes. Not to stop doing the behavior in the first place.

They have a nice graph showing how these penalties have accumulated over time:

Let’s go back to the article:

The 6 percent raises come into play when the Teachers’ Retirement System calculates how much an educator will get in retirement checks. Typically, the educator’s four highest consecutive salaries in the last 10 years are used in the formula.

A penalty can kick in if any one of those salaries increased by more than 6 percent from one year to the next in the same district. Using several factors, TRS first determines the pension with the exact raises included. Then it calculates what the pension would have been had all salary increases been capped at 6 percent. The difference between the pension amounts is used to calculate the penalty.

Part of the problem is using highest salaries. Any version of “highest salaries” or “final salary” encourages spiking behavior of this sort.

One way to get around this would be to base the benefit on a career average salary, or some kind of indexed salary, a la Social Security benefits. It’s a bit harder to move the needle when the average is taken over a 30-year period, indexed or not.

What I wanted to know was what the typical penalties were, and other statistics.

High level statistics:

The average penalty per educator was $5K

There were a total of 7,618 educators involved – Looking at the 2014 CAFR, that represents about 15% of TRS retirees in the past decade

That comes to a total of $38 million over about a decade of these penalties being applied

This is very small compared to the about $60 billion unfunded liability for TRS — less than 0.1% of the UL

So yes, let’s get a grip — these penalties themselves are barely adding to the costs.

However, the spiked pensions do have a cost. Obviously, a pension that is 10% higher than it otherwise would have been is boosting the liability by 10%.

But back to these penalties — how bad is it across the state? I decided to do a graph of how many penalties each district has paid, and unsurprisingly, this graph has a really long tail.

The median number of penalties per district was 4, essentially. I actually cut the horizontal scale short — the maximum number of penalties was 209, for Rockford School District 205, of the city of Rockford in Winnebago County.

I am sure some of these districts are more populous than others – I am not an Illinoisian, so I didn’t know that Rockford was the third largest town in Illinois. There is only one school district listed for Rockford, so perhaps 209 penalties for such a large town is reasonable. Their average penalty was close to $9K per educator, paying $1.85 million in penalties in the almost decade of penalties.

Finally, I tried getting at a distribution of the penalty amounts, and that’s kind of difficult. I’m given only the average penalty per district, and in a district like Rockford, you know some of the penalties were much higher than that average, and some much less. In a district where there was only one penalty, I know exactly how much they got dinged for per person.

I could get all fancy-pants and do some kind of kernel-smoothing to get a full distribution, but dangit, this is a hobby and I ain’t doing a normal-kernel-smoothing thing. It just doesn’t matter.

I graphed this two ways. The first way will be easier for most people to understand:

Essentially, most of the individual penalties are less than $10K, but there’s a really long tail.

To figure out percentiles, I did a cumulative distribution graph:

Let me pull out relevant stats: (rounding for ease of understanding)

Median penalty is about $3,800 per person (so less than the $5K mean)

70th percentile: $5,700

90th percentile: $9,200

95th percentile: $12,000

99th percentile: $22,000

Maximum: $120,000

So you can see there are a lot of relatively small penalties, so it’s unsurprising that the school districts are not changing their behavior. It’s just the cost of doing business…. with Other People’s Money.

It’s so nice when there’s no outside force making you keep costs down.